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Looking for restaurant values amid tough times

It’s always darkest right before it goes pitch black, they like to say on Wall Street. With gas prices up, sugar, corn and chicken prices up and the minimum wage up for the first time since a Harry Potter book graced our shelves, it’s looking pretty dark in the restaurant business. To some extent, merger mania is holding the stocks up, especially after IHOP’s (Symbol: IHP) almost $2 billion bid for Applebee’s International (APPB). But potential deals can’t hide the industry’s poor operating results flowing through the most recent quarterly results. A portfolio of the biggest chains tracked on Stockpickr.com has lost 9% since the end of May.

So far this week, Panera Bread (PNRA), CEC Entertainment (CEC), and P.F. Chang’s China Bistro (PFCB) have reported disappointing quarters. Even many that didn’t disappoint reported lackluster results. Cheesecake Factory (CAKE) said same store sales rose just 1%, matching the similarly negligible 1% rise in net income. Same store pancake sales rose 2.5% at IHOP, where a big change in the tax rate and massive share repurchases helped net income per share leap 46%. Cash flow from operations dropped 22%. All that comes after similar bad news from last month’s reporters like Sonic (SONC), which said its fiscal fourth quarter (ended 5/31) profit dipped 13% thanks to a massive shrinkage in net margins.

But the fact that an industry is under pressure means that the real values may be more evident and likely cheaper to acquire. Not everyone is suffering. See exhibit A: Mickey Dee’s (MCD), still benefiting from menu additions and strategic improvements that took off last year. Yum Brands (YUM) had a great quarter thanks to overseas results, even as U.S. operations at its Taco Bell outposts stunk up the joint.

So who sees value? Money manager (and Seton Hall finance professor) Scott Rothbort offers a bar bell strategy, more commonly associated with the bond market when an investor buys very short-term and long-term bonds but ignore middle maturities. In the case of restaurants, Rothbort is buying a chain at the high-end of the price scale, Ruth’s Chris Steakhouse (RUTH), and one at the deeply cheap end, McDonald’s (MCD). “High end specialty restaurants continue to grow and attract diners despite menu price increases,” he writes. Meanwhile, “energy prices push diners down from the casual dining segment into the quick casual segment.”

Kevin Kelly over at Bloggingstocks.com, likes McDonald’s spin-off Chipotle Mexican Grill (CMG), which had a splendiferous IPO back in January, 2006. With revenue increasing 30% this year and 20% next year, investors remain infatuated with the burrito purveyor, Kelly writes. “Although Chipotle’s valuation is very easy to dispute, in this situation I think the market will remain irrational in the next few months,” he concludes. You’d be in good company, as former hedge fund mavens Jeff Vinik and George Soros reported owning Chipotle’s.